Is There Too Much Benchmarking in Asset Management?

Anna Pavlova, Anil Kashyap, Natalia Kovrijnykh and ,

No 16296, CEPR Discussion Papers from C.E.P.R. Discussion Papers

Abstract: We propose a model of asset management in which benchmarking arises endogenously, and analyze its unintended welfare consequences. Fund managers' portfolios are unobservable and they incur private costs in running them. Conditioning managers' compensation on a benchmark portfolio's performance partially protects them from risk, and thus boosts their incentives to invest in risky assets. In general equilibrium, these compensation contracts create an externality through their effect on asset prices. Benchmarking inflates asset prices and gives rise to crowded trades, thereby reducing the effectiveness of incentive contracts for others. Contracts chosen by fund investors diverge from socially optimal ones. A social planner, recognizing the crowding, opts for less benchmarking and less incentive provision. We also show that asset management costs are lower with socially optimal contracts, and the planner's benchmark-portfolio weights differ from the privately optimal ones. Finally, we consider an application of our model to ESG (environmental, social, and governance) investing and show that optimal incentive provision for fund managers should include ESG-tilted benchmarks.

Keywords: Incentive contracts; Moral hazard; Relative performance; Pecuniary externality; Asset management; Benchmark; Index; Welfare; Esg investing (search for similar items in EconPapers)
JEL-codes: D82 D86 G11 G12 G23 (search for similar items in EconPapers)
Date: 2021-06
References: Add references at CitEc
Citations:

Downloads: (external link)
https://cepr.org/publications/DP16296 (application/pdf)
CEPR Discussion Papers are free to download for our researchers, subscribers and members. If you fall into one of these categories but have trouble downloading our papers, please contact us at subscribers@cepr.org

Related works:
Journal Article: Is There Too Much Benchmarking in Asset Management? (2023)
Working Paper: Is There Too Much Benchmarking in Asset Management? (2020)
This item may be available elsewhere in EconPapers: Search for items with the same title.

Export reference: BibTeX RIS (EndNote, ProCite, RefMan) HTML/Text

Persistent link: https://EconPapers.repec.org/RePEc:cpr:ceprdp:16296

Ordering information: This working paper can be ordered from
https://cepr.org/publications/DP16296

Access Statistics for this paper

More papers in CEPR Discussion Papers from C.E.P.R. Discussion Papers Centre for Economic Policy Research, 33 Great Sutton Street, London EC1V 0DX.
Bibliographic data for series maintained by ().